mispricing

Mispricing refers to a situation in which the market price of an asset deviates from its estimated intrinsic or fundamental value. Such deviations can be temporary or persistent and can occur in equities, bonds, derivatives, and other asset classes. Intrinsic value is typically inferred from discounted cash flows, asset-based measures, or other fundamental models, but uncertainty about inputs means exact values are rarely known.

Causes of mispricing include information asymmetry, where some participants have better or faster information than others; behavioral factors such as overreaction, underreaction, attention biases, and cognitive heuristics; and market frictions like liquidity constraints, transaction costs, short-selling limits, and model or estimation errors. macro shocks and regulatory changes can also create gaps between prices and fundamentals.

Mispricing can take the form of overpricing (prices above intrinsic value) or underpricing (prices below intrinsic value). It may be observed as pricing anomalies or patterns that persist beyond explanations from risk and fundamentals, such as certain value or momentum effects, post-earnings announcement drift, or liquidity-driven deviations. Mispricing is not limited to equities; it can appear in fixed income, derivatives, and real assets when prices fail to fully reflect expected cash flows, risk, or liquidity conditions.

The discussion of mispricing is central to the debate between the efficient market hypothesis and behavioral finance. Proponents of efficiency argue prices quickly incorporate new information, leaving little room for abnormal profits after adjusting for risk. Critics contend that limits to arbitrage, cognitive biases, and evolving risk preferences allow prices to diverge from true value for longer periods, creating opportunities and risks for investors.

Detecting and evaluating mispricing typically involves empirical tests, event studies, and comparisons between market prices and fundamental valuations, always with attention to uncertainty and risk.